Rising interest rates and weaker refinancing activity slowed loan payoffs in the third quarter, enabling many small regional and community banks to post loan growth despite lower overall demand.
Before the multiple Federal Reserve interest rate hikes in recent months,
Many banks rely on the interest income they generate on loans, making them hesitant to compete aggressively on interest rates. In recent quarters, amid competition from nonbanks whose pricing and terms often fall outside of what makes financial sense for community lenders, analysts say, small banks were forced to allow loans to refinance away, and loan growth was constrained as a result.
"That competition got really heated," said Damon DelMonte, a Keefe, Bruyette & Woods analyst.
Bankers also noted some commercial clients and consumers used pandemic-era savings to pay down debt or used cash instead of loans to finance investments.
As such, both loan paydowns and payoffs were high through 2021 and early this year.
By the second quarter, however, rates had climbed enough to make refinancing unappealing for many customers. At the same time, in a higher-rate environment, banks with local expertise and deep ties with business owners in their markets were able to win more loan deals on service. This resulted in new loan growth by the third quarter.
For example, OceanFirst Financial, a $12.7 billion-asset lender in Red Bank, New Jersey, increased loans in the third quarter by more than 3%. It cited both steady origination volumes and declining prepayments.
"We're getting a lot of new traction" since rates started to rise, OceanFirst Chairman and CEO Christopher Maher said in an interview. "What's defined this cycle is the speed at which the Fed has moved."
The Fed in September
Through the end of October, nearly two thirds of community banks had reported third-quarter results, according to Raymond James, and linked-quarter loan growth remained strong at 3% versus 3.9% in the second quarter. Loan portfolios had shrunk 0.2% during the third quarter of 2021, the firm said.
Another case in point: Bank OZK in Little Rock, Arkansas.
Bank OZK had predicted that loan paydowns could
The $26.2 billion-asset bank said paydowns in its national Real Estate Services Group, or RESG, reached an all-time high of $2.34 billion in the second quarter — total loans fell nearly 3% from a year earlier as a result — and Bank OZK had braced for elevated levels through the year
However, as refi activity slowed substantially, third-quarter loan repayments dropped to $1.28 billion. As fewer borrowers refinanced into loans offered by competitors, Bank OZK's total loans rose 4% during the third quarter.
Executives expect the slower paydown trend to continue. "We would expect at least for the foreseeable future that it may not be as heavy," Bank OZK RESG President Brannon Hamblen said during the company's earnings call in late October.
Some banks saw more modest growth, but they anticipate a pickup in the current quarter as refi activity further slows. Provident Financial Services in Jersey City, New Jersey, falls into that camp. The $13.6 billion-asset bank expanded loans by about 1% in the third quarter but looks for more pronounced growth in the final months of 2022.
"Rising rates don't really avail themselves to refinancing with other institutions. So we expect prepayments to … drop substantially," Provident Financial President and CEO Anthony Labozzetta said during the company's earnings call last week. "We're seeing that activity certainly in October to be able to substantiate the statement that I'm making. So yes, I feel good about the loan growth going into the fourth quarter."
